These 4 Measures Indicate That Somi Conveyor Beltings (NSE:SOMICONVEY) Is Using Debt Reasonably Well

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that Somi Conveyor Beltings Limited (NSE:SOMICONVEY) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Somi Conveyor Beltings

How Much Debt Does Somi Conveyor Beltings Carry?

As you can see below, Somi Conveyor Beltings had ₹239.6m of debt, at September 2021, which is about the same as the year before. You can click the chart for greater detail. However, it also had ₹90.3m in cash, and so its net debt is ₹149.2m.

How Healthy Is Somi Conveyor Beltings' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Somi Conveyor Beltings had liabilities of ₹350.2m due within 12 months and liabilities of ₹47.3m due beyond that. Offsetting these obligations, it had cash of ₹90.3m as well as receivables valued at ₹216.3m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₹90.9m.

Of course, Somi Conveyor Beltings has a market capitalization of ₹515.9m, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Even though Somi Conveyor Beltings's debt is only 2.1, its interest cover is really very low at 2.5. This does suggest the company is paying fairly high interest rates. In any case, it's safe to say the company has meaningful debt. We saw Somi Conveyor Beltings grow its EBIT by 3.0% in the last twelve months. That's far from incredible but it is a good thing, when it comes to paying off debt. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Somi Conveyor Beltings will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, Somi Conveyor Beltings produced sturdy free cash flow equating to 67% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Our View

Somi Conveyor Beltings's interest cover was a real negative on this analysis, although the other factors we considered were considerably better. In particular, we are dazzled with its conversion of EBIT to free cash flow. When we consider all the elements mentioned above, it seems to us that Somi Conveyor Beltings is managing its debt quite well. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For example Somi Conveyor Beltings has 3 warning signs (and 1 which is concerning) we think you should know about.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.